CAIRP THE PERSONAL INSOLVENCY

INTRODUCTION The personal insolvency law arena in Canada saw many important developments in 2011. This paper will discuss five significant 2011 decisions which will influence both the direction and the development of personal bankruptcy law. From these, four issues have emerged. First, Canadian courts are relaxing the stringent provisions and allowing creditors to immediately proceed to enforce their rights by lifting the automatic stay of proceedings imposed by the Bankruptcy and Insolvency Act. Second, a re-affirmation of the narrow the use of the equitable jurisdiction of the Court. Third, that the Court will look beyond the descriptive terminology used by the parties to determine the true essence of the asset, and lastly, that there needs to be policy reform in order to ensure that bankruptcy legislation is not tactically used to exclude spouses from what would otherwise be their rightful entitlement.

RE BERENBAUMRe Berenbaum was an application by a Bankrupt for his discharge pursuant to the provisions of the BIA, which application was rejected principally on the basis that the sole purpose of the bankruptcy was an avoidance of a tax liability to CRA. Registrar Nettie began his endorsement by quoting Franklin D. Roosevelt, “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.”

Background The Bankrupt was a 59-year-old bookkeeper, who was formerly a chartered accountant and a licenced trustee in bankruptcy. He lived with his second wife in a rented two-bedroom apartment in an upscale and desirable area of Toronto. The Bankrupt’s standard of living greatly exceeded the Superintendent’s Standards for a family unit of two.

While a C.A. and a bankruptcy trustee, he was a partner in a large national firm, from which he ultimately stole $1.1 million, some of which came from insolvency estates that were under his control. He was charged with this crime and later convicted. It was these criminal charges that led to his first bankruptcy which, not surprisingly, in addition to his various creditors, included extensive legal fees to his criminal lawyer and income taxes assessed by CRA owing on the undeclared stolen money. The Bankrupt testified in Court that he should no longer have had to pay the assessed taxes, as part of his sentence was to repay all of the stolen income. He however, took no steps to expunge CRA’s proof of claim in the first bankruptcy and elected to let the proof of claim stand, unchallenged. The Bankrupt received an automatic discharge, and as a result, he stood released of some $990,000.00 in income tax liabilities and $14,000.00 in GST obligations. In short, he avoided paying Her Majesty over $1 million in taxes.

Once discharged, the Bankrupt was hired as a consultant, earning both a base salary and a draw from profits earned. The Bankrupt invoiced his base salary each year to the firm, through his own sole proprietorship, and declared and paid taxes each year on this income. He also invoiced and was paid GST on this consulting income, however, did not remit any to Her Majesty. Additionally, the Bankrupt did not declare any of his bonus draws of approximately $100,000.00 per year to Her Majesty for ten years.

As Registrar Nettie stated, “one can only presume that he would be continuing to live this way even today,” except that the firm decided to shut down and had to account to the CRA for all of the unearned draws. This resulted in the Bankrupt being called upon to account for the undeclared income. Instead of approaching CRA and re-filing correct tax returns, he declared bankruptcy for the second time, assuming that “he was safe in what he knew would be the protection of the BIA (do not forget that he is a former trustee himself)”. It was only then that he filed “a tax return in which he declared, improperly, all of the draws for 10 years in one tax year”. This resulted in a proof of claim by CRA in his second bankruptcy of approximately $1.1 million.

Decision Registrar Nettie stated that the duty of a discharge court is “…to balance the expectation of the honest but unfortunate debtor for a discharge, relieved of the burden of her debts, with the right of the creditors to be repaid, and the need to maintain public confidence in the integrity of the insolvency system”. The Bankrupt was neither honest nor unfortunate. Despite the fresh start granted by the first bankruptcy, the Bankrupt continued to live beyond his means, flouted tax obligations known to him as a chartered accountant, and sought the protection of the BIA only when caught.

Registrar Nettie went on to say in regards to the issue of creditors and expectations that “it is by now trite law that taxes have a special status not only as to their use, and the fairness of all paying their share, but due to the fact that taxing authorities are involuntary creditors. CRA does not get to assess creditworthiness and refuse to extend credit. CRA must rely on the honesty of each citizen to report income, and apply the tax law fairly and reasonably…The Bankrupt has unilaterally deprived Her Majesty of this.”

“The Bankrupt needs to learn once and for all that he must pay his taxes”. In quoting Registrar Funduk from Re Ginther, 2003 ABQB 352, “Rehabilitation is not the driving factor here. Deterrence is, not just for the bankrupt but more important for others who might be tempted to evade income tax liability by conveniently using bankruptcy as a financial planning tool”. By his own motion the Registrar lifted the stay under s.69.4 of the BIA to allow CRA to immediately proceed to enforce its rights before the discharge of the Trustee.

Implications and Practical Consequences In his decision to lift the stay and allow the CRA to immediately proceed to enforce its rights, Registrar Nettie circumvented the BIA to allow for a creditor to accelerate the process of enforcing recovery from a bankrupt.

Under normal circumstances, where the discharge of the Bankrupt is not granted, CRA would have had to await the discharge of the Trustee before proceeding. In this case, the Registrar accelerated the process by bringing his own motion. This was a very aggressive approach to protection of the integrity of the bankruptcy process. One wonders whether this decision might be used in future to grant creditors similar relief in the face of egregious conduct.

RE JAMESRe James was a motion brought by the trustee for authorization under s.30(4) of the BIA in respect of its proposed sale of the Bankrupt’s interest in real property (the “Property”), and a cross-motion by the Respondent, the wife of the Bankrupt under s.37 of the BIA, wherein exception was taken with the decision of the Trustee not to allow as a deduction from the value of the Bankrupt’s interest in the Property certain amounts which would reduce the value of that interest for the purposes of arriving at a sale price. The Respondent appealed the decision of the Trustee not to allow a reduction in the value of the Bankrupt’s interest which she had agreed to purchase. She claimed the value should be reduced: (1) in an amount equal to payments made solely against the first mortgage; and (2) in the entire amount of the second mortgage by the application of the doctrine of equitable exoneration because she had entered into the second mortgage under duress.

Background Two mortgages were taken out by the Bankrupt and the Respondent on the Property. The Respondent was the sole breadwinner in the family during the relevant time period, and therefore was the source of all of the first mortgage payments that were being made. The payments were made on account of her joint and several obligations under the first mortgage.

The Respondent and the Bankrupt executed an application for a second line of credit against the Property. The line of credit was approved and the entire amount of the proceeds thereof were transferred to the Bankrupt’s corporation essentially for its sole use.

The Respondent deposed that she signed the documents necessary to apply for the line of credit and to secure it against the interests of her and the Bankrupt in the Property under duress. She swore that she did not want to sign the documents and was not given an opportunity to seek legal advice. The Respondent swears that despite her reservations, “she signed because she was ‘afraid that if [she] refused, [the Bankrupt] would blame [her] for the loss of his business and this could result in the break up of our marriage’”.

Decision In regards to the first mortgage, Registrar Nettie stated that “As a matter of trite law, her satisfaction of those obligations, absent some contrary agreement between the mortgagors, of which there was no evidence, entitles her to claim from the co-mortgagor his share of the payments, as made by her.” The Respondent knew that her husband was not doing well in his business and that she was the sole income earner for the family. She could have taken steps to obtain security or a title transfer to protect her in making the Bankrupt’s share of the payments on the Property. “To allow her to revise history and use equity to come back after insolvency and obtain such security is…contrary to the spirit and intent of the BIA”. The legal claim of debt by the Respondent against the Bankrupt cannot be converted into an equitable claim against title, and the mortgage payments cannot attach to the Bankrupt’s title, in law or in equity, so as to bind the Trustee and other creditors.

In turning to the second mortgage, Registrar Nettie stated that the doctrine of equitable exoneration exists for equity to presume evidence of an interest, “the failure of which would result in a harsh legal outcome, where the failure to evidence the interest is the result of some legal or societal, and in any event demonstrated, disability.” The Registrar found no evidence that the Respondent’s failure to evidence an interest in the Bankrupt’s share of the property securing her portion of the line of credit, was due to some legal or societal disability. The Respondent claimed that she had signed documents necessary to apply for a line of credit, secured by the Property, under duress and without the benefit of legal advice, to which the Registrar stated that “the Respondent now wants, in effect a ‘do over’ on this choice”.

The Respondent could have insisted that the Bankrupt charge his share of the property on a first dollar basis. Moreover, several years passed after the line of credit was obtained and the money therein was loaned to the Bankrupt’s corporation, during which time the Respondent could have obtained security from the Bankrupt.

The Registrar found that in choosing to sign for the line of credit to avoid the displeasure of the Bankrupt and a possible breakdown of their marriage, the Respondent demonstrated herself to be competent and a rational economic actor. The Respondent did not prove any disability, societal or legal, to have existed such as to have prevented her from protecting herself from the Bankrupt. She had also failed to convince the Court that such protection of her interest in the Property was ever even their intent.

“Competent adults are to be held to the consequences of their decisions, and it is inappropriate for this or any other Court to enable an avoidance of this based on any notions of presumptive gender inequality or that either gender is somehow necessarily unable to make hard choices, or ought to be relieved from the consequences of those hard choices because of their gender.” “Specifically, married women are no longer chattels of their husbands, and no longer disabled statutorily or otherwise from dealings with their property. They ought and must be accorded the respect of the fully independent and competent adults that they are to make decisions and to both have those decisions be protected by Courts as well as to be held to those decisions by those same Courts.”

It is not in the interest of other creditors to allow the Respondent and the Bankrupt to use equity to wrestle away an amount from innocent creditors. The Court found that the equity of exoneration is not engaged and declined to exercise his jurisdiction to charge the Trustee’s share of the Property with payment. Accordingly, the Respondent’s cross-motion was dismissed.

Implications and Practical Consequences The decision in this case re-affirmed the narrow use of the equitable jurisdiction of the Court. Business decisions made by Trustees acting in good faith and in a commercially reasonable manner will not easily be reversed. The decisions of competent adults will not be overturned based only on the fact that they were put in unfortunate situations that called for tough decisions to be made.

RE SNOWRe Snow is an appeal from the Registrar’s decision holding that the Bankrupt’s Income Replacement Benefits (IRBs) from a motor vehicle accident are property vesting in the Trustee.

Background The Bankrupt was involved in a motor vehicle accident in October 2003. In May 2004, the Bankrupt filed an assignment in bankruptcy, claiming that the cause of the bankruptcy was the motor vehicle accident.

In February 2005, the Bankrupt received an automatic discharge, and in October 2005, the bankrupt, through counsel, commenced an action in the Superior Court of Justice claiming damages as a result of the motor vehicle accident. In the motor vehicle accident action claimed general damages in the amount of $1,000,000.00, special damages in the amount of $500,000.00 and Family Law Act, R.S.O. 1990, c. F3, damages in the amount of $100,000.00. In addition to the damages claimed in the motor vehicle accident action, the Bankrupt also had recourse to certain statutory accident benefits under Ontario’s Standard Automobile Policy, in accordance with the limited no-fault regime in place for motor vehicle accident benefits. Those accident benefits included a claim to income replacement benefits (“IRB”), on a no-fault basis, from the Bankrupt’s own automobile insurer, as opposed to the tort defendants and their insurer in the motor vehicle accident action. The Bankrupt also claimed and received Canada Pension Plan disability amounts, and certain Employment insurance payments as a result of the accident. Although the Bankrupt claimed funds from numerous sources, the nature and interest of the Trustee was only in the IRB entitlement. The IRB entitlement was paid out to the Bankrupt, and the Bankrupt and his insurer agreed to settle the statutory accident benefits obligations remaining, including payment of all IRB to be paid until age 65 for a lump sum of $69,000.00. Of this amount, $45,400.00 was on account of all past and future IRB claims.

While the settlement of the statutory accident benefits claim, including the IRB, occurred after discharge of the Bankrupt, the very right to make the claims which were then crystallized prior to the Bankrupt’s discharge, and, in fact, prior even to the assignment itself.

At the Motion before Registrar Nettie, the Trustee claimed the entire amount as having vested in it as property of the Bankrupt under s.67 of the BIA, since the cause of action arose prior to the date of the assignment. The Trustee also argues that the IRB is on account of the lost future ability of the Bankrupt to earn income, and that that loss is a capital asset, the compensation for which vests in the Trustee.

The Bankrupt claimed that the IRB was income pursuant to s.68 of the BIA, and as such is not available to the Trustee for distribution to the creditors except in accordance with that section. The Bankrupt argued that the capitalization of that income stream does not change or affect its characterization as income, and does not, therefore, make it an asset under s.67 of the BIA rather than income pursuant to s.68 of the BIA.

Registrar Nettie found that the IRB was considered property under s.67 BIA, in that the Bankrupt had, at the time of the assignment, a right to claim and receive it, and chose to capitalize the future stream of money inflow, which it represented. That property right vested in the Trustee at assignment. The Trustee was therefore entitled to receipt of the $45,400.00 on account of past and future claims under the IRB, and if the Bankrupt received this amount from the insurer, he was ordered to forthwith remit it to the Trustee.

On appeal, the Bankrupt took the position that the Registrar erred in characterizing the IRB payment as capital as opposed to income. The Registrar should have concluded that the tort action settlement was for pain and suffering only and thus not part of the Bankrupt’s estate vesting in the Trustee. “As a result, he says the Registrar should have declared the Trustee has no interest in the settlement funds…”

The Trustee took the position that the Registrar was correct in both his determination that the IRBs vested in the Trustee.

Decision The Honourable Madam Justice Mesbur held that the Registrar erred in characterizing the IRB payment as a capital asset. Her Honour stated that “in essence the registrar looked at the source of the funds, rather than at the nature of what they replace…The essential nature of the payment, not its source, should determine whether it is income or not”, and concluded that the Registrar was wrong when he determined that the IRBs were not income.

The Honourable Madam Justice Mesbur allowed the appeal in part, and set aside the Registrar’s finding that the IRB payment is property of the Bankrupt, vesting in the trustee. “The IRB payment is in the nature of income, and is subject to the excess income provisions of the Bankruptcy and Insolvency Act.”

Implications and Practical Consequences Based on the foregoing, it is apparent that the Courts are reluctant to provide creditors with a “windfall” when a bankrupt is the victim of personal injury. The capitalization of future income does not change its character. Moreover, the Courts have stated that the substance of the payment must be the governing factor and not the fact that it takes on a different form than that which was intended.

The proper course of action for Trustees in such circumstances is likely to simply oppose the bankrupt’s discharge rather than seeking to recover proceeds of such settlements.

RE CONFORTIRe Conforti was for a motion brought by the Trustee in Bankruptcy of Mr. Conforti seeking directions as the entitlement of certain proceeds of settlement of litigation in the amount of $275,000.00. The issue was whether a receipt of settlement funds in respect of a motor vehicle accident on account of “loss of competitive advantage” is considered property of the bankrupt to be dealt with under section 67 of the BIA or is considered income to be dealt with under section 68 of the BIA.

Background The Bankrupt filed an assignment in bankruptcy in September 2009. Prior to the Assignment, in December 2007, the Bankrupt commenced a legal action in respect of a motor vehicle accident that occurred in January 2007. The action was settled for $275,000.00, and counsel for the parties to the litigation agreed that, of this amount, $100,000.00 was allocated in respect of “future loss of competitive advantage”. It was also expressly agreed that no amount was to be paid on account of past loss of income.

The Bankrupt did not advise the Trustee of the litigation at the time of the assignment, and it only came to light when his lawyer in the litigation advised the Trustee of the settlement.

The Trustee took the position that the award from the settlement funds represented compensation for the loss of a capital asset. As such, the Trustee said that the Bankrupt’s claim constituted property of the bankrupt for purposes of s.67 of the BIA.

The Bankrupt took the position that the award from the settlement funds represented “total income” for the purposes of s.68(2)(a) of the BIA, which would therefore be dealt with under s.68 of the BIA and not vest in the Trustee as a capital asset.

Decision The Honourable Mr. Justice Wilton-Siegel broke down his decision into separate parts: (1) whether a particular receipt falls within the definition of “total income” in s.68(2)(a) of the BIA; and (2) whether the award constitutes “total income” for such purposes.

The Court stated that a purposive approach to interpretation of “total income” in s.68(2)(a) was needed, as this is what had been indicated by the Supreme Court of Canada in Wallace v.United Grain Growers Ltd., where it held that a payment on account of a wrongful termination was income for the purposes of s. 68(1). In reaching that decision, The Honourable Mr. Justice Iacobucci stated that an award that is akin to income does not lose that characterization because the award takes the form of a lump sum award. Accordingly, The Honourable Mr. Justice Wilton-Siegel concluded that the court should look to the essential nature of the award to determine whether it is income or not despite the characterization of the award provided by the parties in the minutes of settlement.

In applying the purposive approach described above, Justice Wilton-Siegel concluded that the award was income for the purposes of s.68 of BIA. In this case, while the minutes of settlement referred to a “future loss of competitive advantage”, he stated that it was “abundantly clear that this payment is on account of the loss of future income. As a result of his injuries, Conforti is unable to continue to earn income at his previous level. His probable future income has been permanently reduced.” The Court went on to state that because it is unreasonable to assume that no compensation is being paid for the loss of future income in the present circumstances, he concluded that the essential nature of the award is compensation for lost future income. The fact that the award is a capital sum did not change the character of the payment, which is to replace or compensate for lost income. Similarly, the fact that the Bankrupt continues to earn some income was not inconsistent with the award being, essentially, replacement income for the difference between what he could have earned and what he is earning presently and likely to earn in the future.

Based on the foregoing, the Court concluded that the Award is “akin to income”. “It replaces the income in the future that Conforti will never make.” It therefore falls within the definition of “total income” in s.68(2)(a) and is subject to the regime in s. 68 of the BIA.

The Trustee went on to make two distinct arguments. The first argument is that a payment for loss of competitive advantage should be treated as a payment for a loss of future income and, following Andrewsv.Grand & Toy Alberta Ltd., should therefore be treated as an award for a loss of a capital asset.

The Honourable Mr. Justice Wilton-Sigel agreed that the award constitutes compensation for future income loss despite being labelled an award in respect of a future loss of competitive advantage. However, he did not accept the argument that Andrews should govern the treatment of the Award for the purposes of the BIA for the reasons set out above.

The second argument of the Trustee was that regardless of whether or not the treatment of an award for loss of future income is governed by Andrews, the nature of an award for loss of competitive advantage is understood to be an award for the loss of a capital asset and, therefore, should be treated as property of the bankrupt.

The Honourable Mr. Justice Wilton-Siegel surmised that “the important point to be taken from these cases is that the loss of competitive advantage relates to a contingency that is additional to the customarily recognized contingencies that might affect an injured party’s future earnings, such as those set out by Dickson J. in Andrews,at p. 232: unemployment, illness, accidents and business depression, to which should be added mortality”. The concept is directed toward the contingent loss of an individual’s future marketability ─ it may never occur but, if it does, it will do so in a manner that results in diminished income in the future. This raised the question of the relationship of the two concepts: loss of future earnings and loss of competitive advantage. Based on a logical deduction from the Court’s analysis, it can be argued that the concept of loss of competitive advantage is distinct from the concept of foregone future income that is probable as of the date of the calculation.

Based on the foregoing, the Honourable Mr. Justice Wilton-Siegel concluded that the award was to be treated as “income” for purposes of s.68 of the BIA and therefore does not vest in the Trustee.

Implications and Practical Consequences The case is significant in that it shows that the Court will look beyond the descriptive terminology used by the parties to determine the true essence of the asset. Trustees must be diligent in the enquiries made of Bankrupts relative to claims for damages to which they are parties. It is not sufficient merely to differentiate only between income replacement and personal damages (which has been the simplistic standard for several decades); rather it is imperative that Trustees enquire into and look to the true nature of each head of damage on which a potential claim might be based so that the stakeholders in the bankruptcy recover all that is ultimately due to them.

SCHREYER V. SCHREYERSchreyer v. Schreyer is a Supreme Court of Canada decision, which dealt with the issue of whether an equalization payment due to a spouse survived the bankruptcy of the owing spouse. More specifically, the case centred on whether a wife could make an equalization claim against an exempt asset where the bankruptcy occurred post-separation. The case specifically involved a Manitoba homestead exemption but the Court’s reasoning could just as easily be applied to exempt assets in other provinces. Examples of this in Ontario might be pensions and RRSPs.

Background Mr. and Mrs. Schreyer separated in 1999 and filed for divorce in 2000, after nineteen-year cohabitation. At the time of separation, their farm was their sole asset of significance. Under their divorce agreement, the husband was to continue to live on the family farm, which was registered on title in the husband’s name, and their assets were to be valued. Once the valuation was completed, the husband was to make an equalization payment to the wife, equal to the value of the farm. Based upon the valuation, it was determined the husband owed the wife an equalization payment of $41,063.48.

Approximately 4 years later, just before the divorce trial, the husband informed both his wife as well as the lawyers that he had filed for bankruptcy and subsequently been discharged before the valuation was complete. As the valuation determined that the husband owed the wife an equalization payment, the wife would therefore be considered a creditor of the husband’s estate in bankruptcy.

Under Manitoba’s Judgments Act, the family farm was exempt from execution by way of seizure and sale, and while the husband was allowed to keep the farm, the wife’s claims against him for equalization were extinguished by his bankruptcy. When the husband was discharged from bankruptcy he was cleared from his debts and thus could keep the farm. The wife, however, was out of luck, as her entitlement to an equalization payment did not survive the bankruptcy.

Decision The SCC agreed with the Manitoba Court of Appeal and dismissed the appeal on the grounds that her equalization claim was released by the husband’s post-separation bankruptcy. Manitoba was said to be an “equalization jurisdiction”, and not a “division of property jurisdiction” (Ontario is also an “equalization jurisdiction”), and as the wife did not have any proprietary right in the husband’s property, she would therefore only be considered a creditor.

The entitlement to an equalization payment is not an entitlement with respect the actual property of a spouse, and thus, the Court stated that the right of equalization is at most a debt claim. The Court stated that it should not interfere with the Manitoba legislature’s policy choice not to give a former spouse a proprietary interest in family property. The Court acknowledged that this result was unfair: “…the appellant’s equalization claim was based primarily on the value of an asset – the farm property – which was exempt from bankruptcy and therefore not accessible to other creditors. None of the policies underlying the BIA require the appellant emerge from the marriage with no substantial assets. However, despite the unfairness, it was for Parliament to solve the problem, and not the Court itself.

Although the appeal was dismissed, the Court did not award costs to the husband, “in light of the particular circumstances of this case”. The Court appeared to lament the fact that “In its current form, therefore, the [Bankruptcy and Insolvency Act] offers limited remedies to spouses in the appellant’s position”, and stated that “It seems to me that this matter is ripe for legislative attention so as to ensure that the principles of bankruptcy law and family law are compatible rather than being at cross-purposes”.

Implications and Practical Consequences In recognizing the gross unfairness of this outcome for the wife, the Honourable Mr. Justice Lebel noted that law reform on this issue has long been recommended and is urgently required. Instead of permitting bankruptcy legislation to override the intent and effect of provincial family property equalization laws, there ought to be permitted exceptions to ensure that bankruptcy legislation is not tactically used to exclude spouses from what would otherwise be their rightful entitlement. The potential for misuse of this manoeuvre is obvious and while it is within the letter of the law one questions whether it is within its spirit.

CONCLUSION Based on the foregoing, 2011 has been a year with numerous significant developments that may very well alter the direction and development of personal bankruptcy law. The decisions cited have arguably begun to pave the way for considerable transformations in the way in which the Courts view legal principals and issues that have previously been more strictly interpreted.